What impact will CSDR have on custody markets?
The regulation aims to improve on settlement rates for securities settled in European central securities depositories (CSDs) and bring those settlement rates to the highest levels possible. While the initial focus of the regulation seems to be on the negative measures being applied, the Central Securities Depositories Regulation (CSDR) also ensures that trading parties consider preventative measures and perhaps re-consider riskier investment strategies and approaches which might be leading to trade failures. The regulation should gradually apply more best-practice behaviours where trading parties will see and feel the punitive measures of not settling on time. Firms can look to influence their settlement success both directly through internal improvements and developments, and then externally by working with their providers and counter-parties for best results.
Finally, it continues the approach for harmonisation across European markets, following on from the T2S (Target2 Securities) efforts in the past years. CSDR should apply standard approaches to settlement timing, communication and the resulting outcomes such as buy-ins, which has not tended to be aligned across European markets so far.
How are CSD participants preparing for CSDR?
Priorities focus on two areas at this stage – the Settlement Discipline Regime (SDR) and then preventative measures associated with avoidance of the impacts of the SDR. The SDR covers the cash penalties associated with not settling a trade on the Intended Settlement Date (ISD) and also buy-ins becoming mandatory for the markets in scope after a number of business days where a trade fails to settle. Preventative measures look at where proactive steps can be taken to avoid penalties or buy-ins, where possible. The focus of preventative measures looks at stronger partial settlements, indicative reporting and improvement of procedural and communication chains to allow for best settlement rates. Ancillary services such as securities lending and exchange-traded funds (ETFs) also need an investigation to fully understand the CSDR impacts.
Is it important for firms to continue working on preparations around CSDR implementation, even with the deadline push back?
Absolutely – it’s expected that big efforts will be needed ahead of the implementation date. While the push back of the deadline to February 2021 is welcomed, it’s expected that the next six or more months will need much work to be ready. Firms should already have a good sense of their likely impact of the regulation for them, which would combine a view of historical data and trends and then estimating the project effort required to be compliant from the go-live date. Because of the impact across trading functions, back-office, engagement with custodians and other providers – it’s clear that much will need to be done to be fully ready.
Why are there particular concerns around the mandatory buy-ins process?
Indeed, there seem to be more questions than answers at the moment when it comes to the buy-in process becoming mandatory for the markets in scope of CSDR. From one perspective, the role of the third-party buy-in agent seems to need further clarification, with only one confirmed buy-in agent in place, and perhaps one or two others in consideration. The scope coverage which buy-in agents can support is also to be determined, both in terms of operational needs and time-zone coverage, and then also when it comes to supporting buy-ins of various instrument types and asset classes.
Furthermore, there are open questions regarding how buy-ins will flow operationally, in order for securities to be successfully bought in and settled. There are industry discussions ongoing over how the buy-in would be triggered, how the original transaction should be put on hold, what this can mean for responsibility of associated CSDR penalties and buy-in charges, and finally how buy-ins would be reported. The need to potentially trigger multiple buy-ins when there can be a security failing in the middle of a chain of transaction is also being assessed, with a consideration to use a “pass-on” mechanism to avoid needing to trigger multiple buy-ins being proposed.
Finally, there are some debates over ‘downstream’ impacts of buy-ins, such as what would happen in the case of securities price changes from the time of the original trade being agreed to when the buy-in would finally settle. The implications here on fund accounting, net asset value (NAV) calculations, cash availability projections and corporate actions events are being reviewed.
And how will this impact fund liquidity?
Fund liquidity can have a number of impacts as a result of buy-ins becoming mandatory. First off, there is the scenario where a firm would need to fund for both the original transaction which failed to settle on the ISD, and then also for the buy-in which was triggered. This would naturally limit the availability of funding for other requirements, such as securities lending programmes.
There is potential for two buy-ins to be attempted for a failing security, and if neither of those are successful, then a cash compensation scenario is triggered where a cash equivalent should be provided to allow for the failing trade to settle. This cash compensation option can also impact on fund liquidity as it may require adjustment of a firm’s strategy and available liquidity to allow for such settlement.
Do you think asset managers are still struggling to understand the implications of CSDR and the compliance measures they should implement?
Firms are gathering momentum when it comes to understanding CSDR and the impacts for their organisations. Over the past years, there have been many regulations applied to the post-trade world – such as the European Market Infrastructure Regulation, Markets in Financial Instruments Directive, Securities Financing Transactions Regulation, the second Shareholder Rights Directive – and if a sequential view of regulations and go-live dates is taken, then CSDR starts to get more attention as 2020 progresses.
Another challenge can be where the impact of the regulations is vast across an organisation – potentially hitting front office trading operations, back-office support, legal and compliance teams, technology efforts and project work managing the associated resource and budget needs. Bringing all of these efforts together and progressing with defined CSDR focus can take time to get going.
What do you make of ECSDA’s letter to the European Commission asking for a further one-year delay on top of February 2021? Is this extra time needed?
The letter from the CSD community is interesting as it shows where the industry as a whole feels that more time would be required to be fully ready. This shows that it is an industry-wide understanding of readiness rather than a request coming from individual firms or industry associations representing the buy-side, sell-side or custodians. Recent conversations with the European Central Securities Depositories Association (ECSDA) show that they are also working towards harmonisation across their members when it comes to the Settlement Discipline Regime – in particular when it comes to penalty reporting and settlement, message formatting and buy-in handling.
There is recognition that the broad-ranging impacts of the regulation will need time to be fully ready. The European Commission has taken the general approach that there has been plenty of time available to work towards readiness, after the initial publication of CSDR legislative documents in 2014. However, recent events such as the COVID-19 pandemic and the availability of people to continue working on such regulatory efforts would indicate that more work will be needed across the whole industry for infrastructure, messaging and operational alignment. Thus, we await the response from the European Commission to this proposal from ECSDA.
What would your advice be for firms to ensure they are fully prepared in time for the extended deadline?
I would summarise these into the below items:
Understand the regulatory aim and what it expects to achieve, and this will help shape the intended impact for your position in the trading chain.
Assess your instrument types, asset classes and current services which are being traded and settled in European locations – and where possible, use the opportunity to assess historical data trends for likely future impacts. This can allow the chance to view where there may be challenges in certain markets or when working with certain counter-parties when the regulation goes live.
Work with your providers and vendors to confirm likely impacts and assess where you can work together on readiness. Providers may be able to provide certain additional data or reporting which can show your projected CSDR impact. They can also provide market updates, both from their own work to be ready and from what is discussed in industry forums and workshops.
Have a timeline to ‘work back’ from – meaning looking at the go-live date and applying what needs to be in place before then. Keep in mind that with the implementation date scheduled for February 2021, this would likely mean needing to have more efforts in place by the middle of Q4 2020, allowing for some time for any testing, while also considering the year-end freezes that are usually applied for any “change” activities.
Understand the impact on fund accounting and NAV calculations.
Monitor for industry updates when it comes to topics such as the expected implementation date, and other open items of interest such as buy-ins.
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